Michaels Companies Inc
Q3 2016 Earnings Call Transcript

Published: 6 Dec 2016

[Operator:]

Good morning. My name is Rocco, and I will be your conference operator today. At this time, we’d like to welcome everyone to the Michaels Company’s Earnings Conference Call for the Third Quarter of Fiscal 2016. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. And now, I’d like to turn the call over to your host, Kiley Rawlins, Vice President of Investor Relations and Communications. Ms. Rawlins, you may begin your conference. Please go ahead.

[Kiley Rawlins:]

Thank you, Rocco. Good morning everyone and thank you for joining us today. Earlier this morning, we released our third quarter financial results. A copy of the press release is available in the Investor Relations section of our Web site at www.michaels.com. Before we begin our discussion, let me remind you that today’s press release and the presentations made by our executives on this call may constitute forward-looking statements, and are made pursuant to and within the meaning of, the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. While these statements address plans or events, which we expect will or may occur in the future, a number of factors, as set forth in our SEC filings and press releases, could cause actual results to differ materially from our expectations. We refer you to, and specifically incorporate, the cautionary and risk statements contained in today’s press release and in our SEC filings. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today, December 6, 2016. We have no obligation to update or revise our forward-looking statements, except as required by law, and you should not expect us to do so. In today’s earnings release, we have presented non-GAAP financial measures, such as adjusted EBITDA, as defined in our credit agreement, adjusted operating income, adjusted net income, and adjusted diluted earnings per share. Adjusted operating income, adjusted net income, and adjusted diluted earnings per share have been presented to reflect our view of our ongoing operations by adjusting to losses on early extinguishment of debt, non-recurring inventory-related purchase accounting adjustments and non-recurring integration costs associated with the February 2016 acquisition of Lamrite West. A reconciliation of these measures to the corresponding GAAP measures can be found in today’s earnings release. Our call today will begin with the highlights from Chuck Rubin, Chairman and CEO and then Denise Paulonis, our Chief Financial Officer, who will review our financial results and outlook in more detail. Chuck Sonsteby, Vice Chairman, is also on the call with us this morning, and will be available during the Q&A session. Following our prepared remarks, the call will be opened for questions. As a reminder, we would appreciate it if participants could limit themselves to one question and one follow-up. Now, I’ll turn the call over to Chuck Rubin. Chuck?

[Chuck Rubin:]

Thank you, Kiley, and good morning everyone. This morning we reported third quarter sales with total sales increasing 5% for the comparable sales decrease of 2% in adjusted diluted EPS of $0.40 compared with $0.37 in the third quarter last year. We also announced that our Board of Directors has authorized an additional $300 million share repurchase plan in addition to the $44 million remaining under the previous authorization. Despite softer than expected top-line performance, we delivered net income growth adjusted for the Lamrite West acquisition and debt refinancing costs, all while continuing to make investments for the longer term growth and returning cash to shareholders through stock repurchases. Certainly, we had higher financial expectations for Q3. There were external factors that impacted our results but we also learned from our own Q3 actions and have made some adjustments to improve our Q4 performance. I am pleased that during Q3, we continued to make progress on many of our long term initiatives, which we are confident will further strengthen our business. Let's start with the discussion of the progress achieved in the quarter. First, we gained market share. Independent third party data, based on a broad sample of bank craft transaction activity in the cash of sales in the quarter were challenged across the craft segment, reinforcing that we were not alone in the sales challenge. The consumer choppiness we experienced in the first half of the year continued and even intensified in the third quarter. Against this backdrop, however, we continued to increase our market share despite the incremental user promotions by some of our competitors. Second, we continued to see improvement across all of our customer service metrics. Our teams are working hard to improve the shopping experience in our stores, and our customers have noticed. Third, we continued to deliver strong performance in our seasonal product categories; Halloween, Day of the Dead, and floral and décor all delivered nice comp growth, albeit lower than our initial expectations. In addition, new trends like daily planners, washi tape and Caron Cake Yarn delivered strong comp growth. And our new effort early in the quarter to highlight back-to-school basics delivered encouraging results. Finally, our team continues to manage expenses and inventory well through a difficult operating environment. Inventory was flat as compared to last year on a per store basis. Given the long lead nature of our business, we are pleased with this performance, and we feel good about both the quality and quantity of our inventory. We also continued to make investments to support our long term vision. We completed space changes in 280 stores, creating flexible merchandizing space in the front of the store to highlight newness. These changes helped operational effectiveness by reducing the number of store layouts we manage, what we often call snowflakes, and enables these stores to present stronger, more cohesive, seasonal product statements to customers. These layouts are particularly compelling during our peak season. Both elements, simplification of operations and better showcasing the merchandize, are key parts of our Vision 2020 strategy. Enrollment in our rewards program, Michaels Rewards which launched in July has exceeded our expectations and surpassed 10 million customers. As a remainder, Michaels Rewards offers customers tailored exclusive offers and events, such as sneak-peeks for new products, early alerts for big sales, and receipt free returns, all without a point or purchase level requirement. The program adds to our database of customer behavior, which we have begun to utilize, and overtime, will allow us to target our marketing and promotions more effectively. The integration of Lamrite West continues to progress well. This quarter, we incorporated our artistry custom framing platforms into Pat Catan stores bringing additional value to the Pat Catan’s customer and reducing costs. And we’ve made substantial progress in aligning our back-office systems to include key platforms like benefits, talent management, and training. One of our most critical accomplishments this quarter was the scaling-up of our Darice global sourcing team. We expanded our team in Ningbo China and opened an additional office in Hong Kong. The expansion of these teams and the work they are doing is already creating value in delivering sustainable competitive advantages. With these enhanced resources and capabilities, we are closer to the manufacturer and have greater control over the purchase cycle, resulting in the opportunity to both lower product costs and improving, or at the very least, maintaining quality. Finally, we’ve continued to invest in our store infrastructure and systems with tangible, customer facing enhancements like e-mail receipts, while also starting the roll-out of our new POS platform, which will be completed in stores in fiscal 2017. Despite this progress, there were clearly things that we could have done better. Our core basics business was softer than planned, largely driven by the faster than anticipated deceleration of the coloring trend, as well as continued softness in custom framing. In addition, the implementation of the new flexible merchandizing area in the 280 stores, while helping our seasonal product sales, was more disruptive than expected on sales of our core products as customers acclimated to the new layout. Also, in a general retail environment where value was wining with customers, we believe that we should have presented a stronger value statement. Many of our competitors increased promotional activity year-over-year, while we remained relatively consistent. We also reallocated advertising spend from Q3 to Q4, potentially compounding our traffic headwinds. Building on these lessons learned, we have made adjustments to improve our performance in the fourth quarter. Seasonal and trend products have performed well this year and naturally become a larger part of our overall mix in Q4. Building on last year successes, we have added more newness and merchandize exclusives to our holiday assortments, both in-store and online; we’ve expanded the assortment of readymade and crafting ornaments; we’ve increased our selection of trees, adding new colors, shapes and styles; and we’ve introduced a new exclusive holiday décor collections. We believe this is our best holiday offering ever, and are encouraged by the customer response so far. We’ve also continued to improve our in-store presentations to make it easier for customers to shop key seasonal items like ornaments, poinsettias and premade bows. In the highly visible drive by, we’ve opened up the fixtures color coordinated the packaging and improved the signage all to make a holiday presentation of the customer which is both more impactful and easier to shop. These changes, combined with the flexible merchandizing area in almost 30% of the Michaels chain, have resulted in a stronger, more cohesive statement to customers this holiday season. I’m also pleased that sales in stores with this flexible merchandizing area have rebounded this quarter. Custom framing continue to be a challenge in Q3 across Michaels, Aaron Brothers, and Pat Catan. Given the consistency of these protracted trends, we do not believe the market overall is expanding and our planning for these challenges to continue. As such, we are focused on leveraging our vertically integrated capabilities to offer customers unique products at attractive pricing with the intent of taking additional market share from others. We’re making changes in customer communications to highlight the tangible and intangible value we offer to our customer framing capabilities. And we’re looking at new ways to strengthen our store team members’ selling focus in this high service high touch category. It's also clear from results across most of retail that customers are looking for value. At Michaels, our average item retails for approximately $3, which is certainly an appealing price point. We do not need to broadly lower our price points, but we can make a stronger visible statement to the customer. Beginning this quarter, fourth quarter, Michaels will put greater emphasis on the values we offer through the use of whole dollar price points and key items, which will be highlighted in-store with in-stock presentations and very visible signage. In addition, we are testing a new everyday low price program on a limited number of highly visible items across a broad range of categories to provide clear compelling value to the customer who doesn’t want to wait for a sale or a coupon. In early next year, we plan to expand this effort to include maker must haves, a new presentation of core creativity products at compelling price points positioned in the highly visible check-out lane. In addition to our in-store presentations and value messaging, we will also adjust our promotional strategy. Leveraging our new loyalty program, we intend to be more targeted with deeper promotions, focusing on offers which resonate with specific customer segments. As a remainder, in our business, the most common type of promotion is a discount on one item in a customer transaction, which usually consists of approximately seven items. This is very different from the store wide deep discounts that we all see today that happened at apparel retailers. Finally, as the largest player in this segment, we are leveraging our position by increasing our marketing spends to both drive additional market share gains and to strengthen the Michaels brand. Last month, we launched a fully integrated brand campaign intended to leverage the growing consumer trends of DIY and personalization, while also positioning Michaels in a more contemporary life. Utilizing increased television, radio, social media and in-store events, our goal is to differentiate the Michaels brand, broaden our reach and drive increased customer engagement. Hopefully by now you’ve had a chance to see our new television commercials. Launched after the election, this year's TV campaign is planned to have more exposure and more reach than last year's campaign. In addition, we’ve launched a new four part integration with the number one national morning program, Good Morning America, to highlight how easy and fun it is to make something unique and personal this holiday season. Each segment is linked to a family focused in-store experience to drive customer engagement and sales. And finally, we have launched a new digital content series, which highlights some unexpected celebrities, paddling it out in a make competition to create fun projects for the holiday season. To maximize the impact of these investments, we’re supporting all of these efforts with targeted direct and digital marketing. This new program has gotten off to a very strong start. Our in-store events have attracted more than 50,000 customers and our new digital content series has garnered more than 10 million views and 200 million impressions. Given the reaction of this integrative brand campaign, I am confident that we are reaching new customers and positioning Michaels in an unexpected more contemporary like. All of these changes, which include our increased emphasis on value, our investments in marketing and our focus on seasonal merchandize, are having an impact. Post election, we have seen an improved sales trend, including over the Black Friday weekend. While we are encouraged by these trends, we think it is prudent to take a conservative view of expectations for Q4. Some of our biggest holiday selling weeks lie ahead and weather it is always a consideration. Additionally, this year, we have seen our customers shop more freely around events only to pull back between natural event drivers. In closing, we know our industry is facing some headwinds. We are confident that they are temporary. However, we cannot be sure how long they will persist. In the meantime, as industry leaders do during cyclical slowdowns, we will leverage our strength to take market share and drive operating profit dollar growth. We will project more value, continue to highlight the best trends in seasonal product, be targeted and deepen our promotions, and market aggressively to get our message out. Our product sourcing efforts, which we have been working on since Q4 2015 and which are now enabled by our owned China office capabilities, are beginning to provide meaningful savings. While these savings are sustainable long-term benefits, we will likely invest much of these savings in the near-term to grow sales and profit dollars. We are the biggest in the industry and have retail leading margins and consistently generate strong cash flows, even in difficult operating environments. And we will continue to invest to support our long-term strategy for growth, while also continuing to manage our balance sheet and return cash to shareholders through share repurchases. And now, let me turn the call over to Denise for a more detailed discussion of our financial performance and outlook. Denise?

[Denise Paulonis:]

Thanks, Chuck and good morning everyone. Our third quarter total sales increased 5% to $1.23 billion, up from $1.17 billion last year. The increase in total sales was primarily due to $65 million in sales from the acquisition of Lamrite West and $17 million in sales related to the operation of 19 net additional stores during the period. For the quarter, comparable store sales decreased to 2%. Although average ticket increased, the improvement was more than offset by decline in customer transactions. As Chuck said earlier, we have made changes in a number of areas to reverse this trend and improve our future results. Looking at trends during the quarter, sales slowed as the quarter progressed. Regionally, our Canadian operations outperformed our U.S. markets and delivered a positive 1.3% comp on a constant dollar basis. During the quarter, we opened 14 new Michaels’ stores and relocated four Michaels’ stores. At the end of the quarter, our total store count for all brands was 1,368 stores. Gross profit dollars for the quarter grew slightly to $467 million. As a percentage of sales, our gross profit rate for the quarter was 38% versus 39.8% last year, a decrease of 180 basis points. Approximately 70 basis points of this decrease resulted from the acquisition of Lamrite West, including 700,000 of non-recurring inventory related purchase accounting adjustments. As we’ve discussed on previous calls, the Lamrite West wholesale business has a lower gross margin rate than the Michaels business. As context, the gross profit rate, excluding the impact of Lamrite West, deleveraged by about 110 basis points. We’ve made progress towards achieving our goal of reducing costs through the expansion of our global sourcing capabilities, as well as our efforts to reduce our product acquisition costs. We saw some initial benefit from those efforts in Q3, and we expect these savings will ramp up as we move through Q4 and to fiscal 2017. However, in Q3, these improved sourcing and pricing efficiencies more than offset by a higher mix of sales for merchandize sold on promotion. While we remained relatively consistent in our use of promotions during the quarter, our customers bought more in promotion or more with the coupons than we’ve seen historically. In addition, Q3 gross profit rate was impacted by the timing of distribution expenses, which follows the flow of inventory. Most of this pressure was anticipated and included in our Q3 guidance. But the impact was tightened by lower than expected sales, which also resulted in the delivering of store occupancy costs. Total store rent expense for the quarter was $98 million versus $92 million last year with the increase due to a net 54 additional stores, including 35 Pat Catan stores. SG&A expense, including store preopening costs, increased 3.4% to $320.3 million or 26.1% of sale from $309.7 million or 26.5% of sale in the third quarter of fiscal 2015. This increase in SG&A was primarily due to $17 million associated with the acquisition of Lamrite West, including $2 million of integration expense. As context, excluding the impact of Lamrite West, SG&A expanse, including store preopening costs, decreased by about $6 million. The decrease was due to decrease in incentives based compensation. As we’ve discussed on previous calls, we believe in taper performance and accrue incentive compensations based on our operating income performance. Additionally, we had a decrease in marketing expenses. We shifted our spends to invest heavily in marketing in the fourth quarter to expand our reach. For the full year, we expect advertising expense will be flat as a percent of sales. These declines were partially offset by additional expenses associated with the operation of 19 net additional stores, and increase in personnel cost and additional professional fees related to our sourcing and tax initiatives. During the quarter, we’ve realized base in 280 stores to create dedicated base in the front of the store for seasonal presentations, and improved operational efficiencies. These changes did not require a large capital investment, but we did incur some additional labor and supply expenses, which were funded by our ongoing fuel for growth efforts. As Chuck mentioned, the sales disruption was greater than we expected as customers became acclimated to the new layouts. However, these stores are well positioned to present better holiday statements to customers and we are encouraged by the improvement of their relative performance quarter-to-date. Excluding non-recurring, inventory related purchase accounting adjustments and integration expense, related to Lamrite West, adjusted operating income was $149 million compared to $156 million in the third quarter of fiscal 2015. As a percent of sales, adjusted operating income was 12.1% compared to 13.3% in the third quarter of fiscal 2015. For the quarter, interest expense was $32 million, down $2 million from $34 million in the third quarter of last year. This decrease was due to the voluntary principal payment of $150 million on our term debt in December 2015, and the interest savings from the refinancing of our ABL in May of this year. During the quarter, we successfully amended our term loan credit facility, extending maturity to 2023, and eliminating near-term refinancing risk. I'm pleased to share that the deal was oversubscribed with the majority of lenders amending and the senior lenders joining the group. In addition to extending the maturity to 2023, we also consolidated the existing two tranches into one, resulting in better overall rate terms. As a result of amending our term loan credit facility, we recognized $7 million in losses on the early extinguishment of the debt in the quarter. The effective tax rate for Q3 this year was 29% compared to 37% for Q3 last year. This was lower than our guidance of 31.4% as pretax income was lower than expected. As anticipated, we benefited from discreet items related to certain federal tax credit and decreases in state taxes. We’re also beginning to realize sustainable benefits from our global sourcing initiatives, which have lowered our consolidated tax rate. We have created a strategic advantage with the expansion of our existing China office and the opening of a new office in Hong-Kong. In addition to negotiating lower costs, this new capability gives us more control over the manufacturing process and an opportunity to deliver even more value to our customers. Excluding non-recurring inventory related purchase accounting adjustments, and integration expense related to Lamrite West, and to the losses on early extinguishment of debt and refinancing costs, adjusted net income for the quarter increased 6.7% to $82 million or $0.40 per diluted common share compared with $77 million or $0.37 per diluted common share in the third quarter last year. Now, turning to the balance sheet. Total merchandise inventory was $1.4 billion, up $117 million or 9.2% from the end of Q3 of last year. This increase in total inventory included $95 million in additional inventory related to the acquisition of Lamrite West. As expected, average inventory per Michaels’ store, which includes ecommerce and distribution center inventory, at the end of the quarter, was $1,040,000, about flat with average inventory per store at the end of the third quarter of last year. Our liquidity position remained strong. At the end of the quarter, cash on our balance sheet was $150 million, total debt was $2.8 billion and our revolver availability was $793 million. Debt to adjusted EBITDA remains flat with Q2, but lower than Q3 last year at 3.2 times. Cash capital expenditures for the quarter were $44 million compared to $26 million last year, primarily due to IT investments related to our new POS implementation. We continued to utilize our strong cash flow and balance sheet to return value to shareholders by managing our debt obligations and opportunistically repurchasing shares. In addition to amending our term loan credit facility, in Q3, we purchased 1.2 million shares for about $30 million. Given the timing of purchases, there was minimal EPS benefit for the quarter. At the end of the quarter, we had about $44 million left under the current repurchase authorization. Our Board of Directors has authorized an additional $300 million to bring the total available to $344 million. As a reminder, the share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements, and regulatory requirements. In summary, the third quarter was more challenging than we expected, averaging our performing, we identified specific opportunities for improvement. And we believe we have made the necessary adjustments to improve our performance in the fourth quarter. However, we don't necessarily see big external catalyst for the macro operating environment to improve. Consequently, we believe it is prudent to take a more conservative view of Q4. As Chuck indicated, we feel good about the recent customer response to the business. Customer demand deteriorated significantly in early November and the days leading up to the election. But we have seen positive comp sales growth since the election. However, there is still lot of time left in the shopping season, and those weather and consumer behavior, are just close to project. Our Q4 comp guidance of flat to down 1.5% reflects these factors as well as for volatility we saw in Q3, and the tough comparison to last year. Operating income for the quarter is expected to be between $335 million and $348 million, excluding non-recurring inventory related purchase accounting adjustments and integration expenses related to Lamrite West. Our guidance for operating income includes the affected benefits from a companywide effort to reduce product first cost and our enhanced global sourcing capabilities. Reflecting Chuck’s comments, our guidance also reflects the assumption that we will reinvest much of these savings to support the investments we are making in marketing and targeted promotions. We expect interest expense to be approximately $31 million, reflecting ongoing benefits from the refinancing of out ABL in May of this year is a successful amendment of our term loan credit facility in September. We are planning for the Q4 tax rate to be approximately 36%. This translates to the Q4 adjusted diluted EPS guidance of $0.94 to $0.98 per fully dilutes share, assuming as a late diluted weighted average common share count of 204 million shares. For the full year, we now anticipate total sales will increase between 5.8% and 6.2% and comp store sales will be approximately flat. We believe adjusted operating income for fiscal 2016 will be in the range of $724 million and $737 million, including impact of Lamrite West, but excluding integration costs and non-recurring inventory related purchase accounting adjustments. For the full year, we anticipate that interest expense will approximately $127 million and expect our effective tax rate will be approximately 35%. This translates to an adjusted diluted EPS range of $1.86 to $1.90 for fiscal 2016, using a diluted weighted average share count of $207 million. This guidance includes the impact of Lamrite West but excludes integration costs and non-recurring inventory related purchase accounting adjustments and the losses on early extension of debt and refinancing costs. Finally, we now expect the capital expenditures for 2016 will be between $115 million and $125 million, reflecting the timing of new store openings and efficiencies gained in project spends throughout the year. All-in-all, I am pleased that our retail leading margins and consistent strong cash flow enable us to grow adjusted diluted earnings per share in the quarter. We continue to invest against our long term strategic priorities and ramp up benefits associated with our product sourcing initiatives as we head into fiscal 2017 to [technical difficulty] as well as pursing market share gains while increasing shareholder value. And with that, I would like to open up the call to take your questions. Operator?

[Operator:]

Thank you. We will now begin the question-and-answer session [Operator Instructions]. Today's first question comes from Seth Sigman of Credit Suisse. Please go ahead.

[Seth Sigman:]

When you guys look at the slowdown in the quarter, you alluded to a bunch of different issues. How was your weigh these issues between the consumer choppiness and the election, the competitive dynamics, maybe product drivers like adult coloring books and lapping net and then some of your own internal disruption that you alluded to? And then when you think about comps now positive since the election, which of those components would be getting better?

[Chuck Rubin:]

Seth, I think, when you look at various factors and try to break those out, we’re going to try to avoid detailing each one of those factors. So I don’t think that’s the press that we want to get into. But when you look at coloring and the deceleration more than we anticipated in the third quarter, you do look at the election, there was a little bit of weather impact from the hurricane that hit in the third quarter. That’s the lion share of our negative comp. Now, we commented that this flexible merchandizing area, we sometimes call it the seasonal pad, that had a residual effect on our core inventory as kind of that phenomena of somebody moved my cheese and we had to get customers re-acclimated to where the product was, so that have an impact as well. But a lot of these external things with the driving forces, even without those the comp was not stellar. Since the election, we commented that our comps have been positive. So clearly the election is behind us. The coloring impact, we anticipated so far the impact properly that would have on us comping against that. But our seasonal business and the things that we’ve been doing to improve our seasonal business has started to kick-in. This flexible merchandise area has started to kick-in. Our increased marketing has started to kick-in. And then, ultimately, it does seem as though, from what I hear and read from other retailers, the consumer is in a better mindset in the past couple of weeks. So, I think that would be how we would address your question.

[Seth Sigman:]

And then my follow-up is around the investments. You alluded to -- it sounds like you’ll invest some of the savings related to your sourcing initiatives, if I caught that right. Does that mean reinvest in price or marketing, or somewhere else? And as you think about the net effect on operating margins, I realized it's early for next year. But to the extent that helps drive market share gains and get you back to positive comps. Do you think we can see margin expansion in 2017?

[Chuck Rubin:]

Well, we’re not going to talk a lot about 2017. This sourcing effort that we’ve going through since the fourth quarter of last year, we’ve talked about it briefly in another calls. We are seeing real benefits from that. They are sustainable benefits. Now, we had hoped that a lot of those benefits would flow to the bottom line, but we have also commented that we would be spending some of it. At this point, we will be investing, quite honestly, more than we had anticipated in a variety of areas, including marketing and including targeted promotions to play on picking up market share. We are already at very high margin of rates. Over the long term, we think that they have the potential of going higher. But over the short term, we are planning for margin dollars. And hence, some of those sourcing investments will go towards pursuing that. We’re very fortunate in the strength, and one of the many strengths of our business model, as such that we have those sourcing benefits coming in, and allowing us to pursue a more aggressive strategy without eroding our operating margin dollars. And that’s what we’re focused on right now is to play at the advantages of being the number one player in the industry, pick-up operating margin dollars, leverage the benefit of this sourcing initiative, and take additional share.

[Operator:]

And the next question comes from Christopher Horvers of J.P. Morgan. Please go ahead.

[Christopher Horvers:]

Want to shop on both those question, so you mentioned positive since the election. Are you -- just to frame that out a little bit, are you positive on a quarter to date basis? And have you seen any sort of, like you to alluded to, sort of pull back in the consumer post Black Friday?

[Chuck Rubin:]

No, what we said is that we were, I think, I can’t remember what adjective Denise used, but we were negative going into the election. And we were -- it was a -- the negative trend going into the election was worst than our third quarter trend. So, it slowed in a material way. Since the election, both, the election what was behind us and a lot of our efforts kicked-in. Our marketing kicked in. We did not start our TV until right after the election, so, since the election. And then it has only been a couple of weeks, I know it seems like an eternity, but it’s only been a couple of weeks we’ve seen positive comps. So between our efforts that we have put forth, and we think just a mind-set on the consumers’ part in that urgency to shop, we are a big player at Christmas time. There is a lot of decorating that goes on, that place to our sweet spot, all of those things, combined, I think have translated to our positive comp. Now with that said, keep in mind the guidance that we’re providing for the full quarter, it is a long quarter; the first couple of weeks were rough; the second couple of weeks were positive; it’s a long quarter to go with still things that could be unexpected, including how the customers face shopping in this long window of time between Thanksgiving and Christmas.

[Christopher Horvers:]

I’m trying to think about earnings growth in the fourth quarter, and then contrasting that to be year. You’ve got operating come up about 5% to 6% at the midpoint in 4Q on a negative comp. Is there anything that is reversing or unsustainably positive in there, perhaps incentive comp? Or is the timing of the Lamrite wholesale business reorganization turning to a significant positive from a drag that has been in past three quarter? Because by contrast, operating income is expected to be about 1% on the year on a flattish comp, so just trying to reconcile these two, especially as we start to model out 2017.

[Denise Paulonis:]

Chris, a couple of things to think about there; first, you are correct that the Lamrite West impact on the businesses is specifically just the impact of the naturally lower gross margin rate a base a bit in Q4. So there is a bit of a benefit there. More pressing though is that we do see that in Q4 that sourcing benefit, we do anticipate ramping up. It would still ramp up into 2017. And while we expect that we would be reinvesting some of that, the drag from any promotional investment would be a little bit less given the sourcing benefits. Secondly, in Q4 versus Q3, we do expect that distribution related expenses will become neutral to positive compared to being a drag on Q3. And finally, as we talked about in Q3 and we anticipate in Q4, we do believe that there will be some continued impact associated with our incentive based comp. We do pay for performance. And as such, if we are not delivering against EBIT, which is the primary metrics that we take onus on, we would reduce incentive based comp. And offsetting that, we would have increased expense in advertising and marketing, as we had mentioned shifting to support the brand campaign in Q4, as well as all the TV advertising that goes along with that.

[Christopher Horvers:]

And just one housekeeping question. So, as you think about what's the right go-forward tax rate beyond the fourth quarter, and is there seasonality to that. And then is 2017 a 53rd week, and how does impact the business? Thank you.

[Denise Paulonis:]

So, I'm not going to provide any specifics on 2017. When you think about the average of where we’ll end to the year, we’ll end this year around the 35% tax rate. We would anticipate that we would continue to see some goodness associated with a lot of our sourcing efforts going forward. You will also always see seasonality associated with our tax rate as we file our taxes in Q3. And that is timing that we will always realize any discreet income items that are coming through that would play into our overall rate for the year.

[Operator:]

Thank you [Operator Instructions]. Our next question today comes from Steven Forbes of Guggenheim Securities. Please go ahead.

[Steven Forbes:]

Regarding the incremental promotional activity within the industry. Can you provide some context around your own participation levels? Meaning how did you or how do you plan the balance and need to be competitive and resonate with the core consumer with the idea of protecting profitability. Are you reading or following that these discounts? And how is the participation across the industry change right first past quarter when we talk about that it wasn’t everyone, it wasn’t as broad. Has it become broader in the participation levels?

[Chuck Rubin:]

Yes, in the third quarter, both frequency and depth of discount that we saw from most of our big box competitors, not all but most, increased. We did not generally increase either of the debt or frequency of promotion. What we did see is the consumer took advantage of those promotions more than she had before. So, in other words, it's just -- and this is an last set of example. But the coupon, the number of coupons we've put out there, was consistent with what it would have been a year ago. But the customer was using them more, because obviously not a 100% of customers use any discount level that we have. We stood rather firm in the third quarter. We did take share in the third quarter. We believe we could have taken more. And in the fourth quarter, we will be more aggressive. Now, again, I tried to point this out on -- during the prepared comments. We're going to be aggressive on a targeted basis. And what is really critical to understand is unlike what you see in a lot of other retailers, like apparel retailers, where they put 50% off the entire store that is not the type of promotion that we run. Most of our promotions are off of a single item in a transaction that's made up of seven items, so only one of the seven could be discounted. Many of our deeper discounts will be targeted to loyalty members. So this isn’t -- we’re trying to strike a fine balance, and we think we’re doing it so far pretty well of being more aggressive, fighting for more share, but not -- obviously, we’re paying close attention to the margin dollars we’re generating. And we have the advantage of the sourcing benefit, which is -- we started to see some benefit in the third quarter. We see some upside on the sourcing opportunity in the fourth quarter, and then it continues and ramps up in 2017. So, put simply to your question, we have a lot of ammunition being created by the sourcing program. We had hoped to not to use as much of it as we will in pursuing additional operating income dollars, but we are prepared to be more aggressive. And again, let me stress, that does not translate, as I think we’re guiding in the fourth quarter. We do not plan on eroding our operating margin dollars. We -- and in fact just the opposite, we plan on pursuing these sales and operating income increases by being more aggressive.

[Steven Forbes:]

And then as a follow-up, regarding the trends within the custom framing business. Do you think there is anything to do fundamentally to turn the business around? Can you do something practically buy for one, or expanded product offering into different types of framing? Or do you really wish, as you mentioned there is a perpetual headwind to grow. And on that topic, can you touch on what the impact was in the quarter, or is this not something you want to give color on?

[Chuck Rubin:]

Yes, I don’t think we want to give color on the third quarter. Other than to say it is -- we’re the biggest in the industry. It’s a single digit percent of our overall business. It is a profitable part of our business. It’s a business that we’re very committed to. But I would be lying if I said we’re not frustrated with that business. We have tried a lot of different things where we are trying assortment changes and some marketing changes. But we know that there is a slowdown. I mean when you look at market share in the custom frame business, between Michaels and Aaron Brothers, which is a small division we have in Pat Catan, we’re a giant portion, the biggest portion by far, of market share in the industry. And we’re seeing the slowdown across all brands. So we’re working it hard. We’re making adjustments on the assortment. We’re trying to show some of the intrinsic value of the product, because it’s a very emotional thing. You’re only framing something that you really have a great deal of care about. We’re trying to play that up better. We’re trying to retrain and provide some new training for our team members in stores. But we’re trying to be realistic as well and we have not been able, as hard as we’ve worked to be able to get this trending on a consistent basis, a lot better than it was. So, therefore, we’re going to be conservative in how we are financially forecasting.

[Operator:]

[Operator Instructions] Today's next question comes from Mike Baker of Deutsche Bank. Please go ahead.

[Mike Baker:]

I'll ask about the overall industry trends. You cited some credit card data telling us that the industry has slowed. Can you give us some sense or quantify what that looked like in the third quarter versus previous quarters, and if you’ve seen that pick-up at all since the election as well?

[Chuck Rubin:]

Let me answer the last part first, Mike. That credit card data comes to us with a few week lag time, so we’re two weeks out from the election. We do not have that credit card data yet. Remember, we’ve always said this industry is a slow growth industry right now, the very low single digit grower. In the third quarter, the data would suggest that it doesn’t put a finite number on the growth of the industry, because it doesn’t measure every player in the industry. But there is plenty of evidence to suggest that that very slow growth slowed further. And was either -- it could have been down a little bit. What we do know is based on that data how we shook-out versus all the other major -- material players in the industry. We just don’t have a good bit on the total industry.

[Mike Baker:]

And as a follow-up, does that include online data as well? And did you see any increased competition there?

[Chuck Rubin:]

There was some increased competition. Online continues to be on the fringes here as opposed to a main driver. I will remind everyone that we do also get an interesting perspective of 360 degree view of the industry given our Darice relationship. And we do see what they -- and they are shipping to lots of different retailers, brick-and-mortar, as well as online. And you can see the slowdown just in the purchase orders that people were placing with them.

[Operator:]

[Operator Instruction] Our next question today comes from Simeon Gutman of Morgan Stanley. Please go ahead.

[Simeon Gutman:]

Well, let me ask more -- focus on the Internet as a follow-up to last question. Can you tell us what your business grew at? And it sounds like you could rule-out the Internet threat, because it sounds like you’re selling into some bigger parties there? And then can you elaborate and talk about your broader omni-channel strategy. What -- are you considering any changes with how you do pick-up in-store and/or shipping charges? Just curious like to be able to put that in context to the extent that could be holding back any online business.

[Chuck Rubin:]

So, Simeon, in general, what we’ve said since we went public is still accurate. We’ve said all along that the online part of commerce is an interesting opportunity for us that we think we need to play in. And we have stepped up how aggressive we’re playing in that space. But we still believe that, unlike other industries, this industry will not grow to be double-digit penetration for online business. So, to answer your questions specifically, we saw very nice growth in our online sales in the third quarter, but it's off of a very small base. And in total, it's still a very small portion of our overall business. So we will continue to grow it. We still believe in it. We think that the omni-channel component is important. To some of your other questions about shipping from store or online pick-up in-store, we’ll talk more about that as we get into our next call. But you should expect us to be offering those things as we roll into the New Year, let me just leave it at that. As far as omni-channel, we have stepped up digital communications. So just something like our effort that we’re running right now in social media and in online and even in brick-and-mortar and trying to get customers activated through this Good Morning America promotion and this make off competition that we have with the celebrities online that then brings customers in stores, that kind of omni-channel integration of communication and experience that we feel very bullish on. So very bullish on that, good about the opportunity for online, but it’s still just a minor player overall in terms of our penetration. And we don’t see -- we still don’t see the Amazon’s of the world becoming game-changers by any means in this industries as they have in other industries.

[Operator:]

And our next question today comes from Matt Fassler of Goldman Sachs. Please go ahead.

[Matt Fassler:]

I want to talk for a moment also about promotions. Can you talk about whether there were particular categories that you saw impacted here with a particular focus on Halloween, where referred about some volatility from some of your peers?

[Chuck Rubin:]

I don’t think I’ve categorized it as Halloween. It was just broad-based very deep couponing, very deep promotion that had extended time frames attached to it. So, not the one-day sell but the three day sell, and the seven day sell, and then offer a day and then back on. So, it was not targeted towards seasonal. It was more on core basic product.

[Matt Fassler:]

And just as a follow up to that. Can you talk about how Halloween went throughout this peak again -- there is category timing, you still think it probably wasn’t particularly good based on the cadence you described. But if you think about your efforts in that category I know has been upsized of late?

[Chuck Rubin:]

No actually Halloween was -- we’re very pleased with Halloween. It startled third and fourth quarter. Halloween, I think, Halloween was on Monday, if I recall. But we were -- it was relative to the total box. It was good. It was positive. It was a little bit less than we had hoped it to be. But nonetheless it was positive, and strongly positive.

[Operator:]

Thank you. Our next question comes from Dan Wewer of Raymond James. Please go ahead.

[Dan Wewer:]

Chuck, I was intrigued by your comments about expanding or introducing in everyday low pricing strategy, that seems to be very different from the way that Michaels is going to market in the past. Can you talk about what portion of your business could move to EDLP? And what was the near-term risk in that that may take your customers two to three quarters to recognize the change and moving with high level pricing strategy?

[Chuck Rubin:]

Just to clarify, I think, you’re describing it a bit more aggressive than I would describe it. This is a limited number of skews that are core basic skews everyday kinds of items that we have been testing for a bit of time. We’ve been testing it in Canada for a while. We’ve brought it into the U.S. It’s a select number of skews. So far the test is encouraging. It is not a transition of our store-wide pricing strategy. This is a high-low business, but these are -- we believe that there are two things that we need to do better. This one is one and as I say, it’s bit of test. And as we move into 2017, you will see different -- the kind of core essentials, the milk and eggs of our business that we will be trying this program on. The second issue is just highlighting the really good values that we have already. To use them, just as an example, but the five-below approach of big price point signs on items with good inventory behind them is something that we believe we can do better. And at a time when value seems to be raining supreme in most customers’ mind, we think that we have that opportunity to be doing a better job with it. So, it doesn’t involve us lowering our price. It's simply involves us taking our current price and showing it more prominently. And if you walked into our stores now, and over the next month or two, you will see that stressed better than it has been before.

[Operator:]

Thank you. Our next question today comes from Alan Rifkin of BTIG. Please go ahead.

[Alan Rifkin:]

Chuck, you had mentioned that there to be allocation of the advertising expenses from Q3 into Q4. Can you maybe just shed some color on what the positive benefits is built-in to the incremental advertising in Q4, and how that's incorporated into your comp guidance?

[Chuck Rubin:]

Alan, it's baked into our guidance. So that's all I would say. I would say in hindsight it may have been, I'm not sure that -- if we had to do it over again, I'm not sure that I would pull back on advertising in the third quarter. I think we're being as transparent as we can. They were clearly some things in the industry that slowed down. There were some external factors that impacted us. But there were some things that in hindsight we wish we had done a little bit differently. So pulling back on advertising was one of those. But the incremental spend in the fourth quarter is all incorporated in the guidance that Denise talked about.

[Alan Rifkin:]

Okay…

[Denise Paulonis:]

Go ahead, Alan.

[Operator:]

I apologize ma'am, I removed him from queue as you were about to speak.

[Denise Paulonis:]

Rocco, I think we have time for one more question. Before we go to that question, I want to follow-up on a question asked earlier about the 53rd week. Yes, fiscal ’17 will be a 53 week year for Michaels. Rocco, can we have the next question?

[Operator:]

Of course. The next question is from David Magee from SunTrust. Please go ahead.

[David Magee:]

Just to clarify into my question. The early November of the first week, as it sounds like it was down obviously a good bit. But in the four weeks that we've had since the election, you've been running positive. And so I just want to clarify that. And then, secondly, the -- I'm just curious when your peak is for holiday sales, just given that how much your merchandisers use for decorations and things like preparation stuff. When do you actually peak and had really good visibility, and what the fourth quarter looks like?

[Chuck Rubin:]

So, just to clarify your timing a little bit. In our fiscal calendar, help me out guys. The election was the second week of our fiscal November. So it's not quite the timing that you've just described, it's not clearly since the election. So just to kind of get that behind us. As far as that the -- we’re not going to break-out week-by-week. December is clearly the biggest month in the quarter. And there is heck of a lot of business still to come. So, pleased about how business has been since the election. There is a ton of space to go. We go through -- I will say this. We do go through a slight shift where the core is in earlier sell and then it shifts more into gift giving. And it's a slightly different customer mentality. So we are going through that transition now.

[Operator:]

And thank you. This concludes the question-and-answer session. I'd like to turn the conference back over to Chuck Rubin, Chairman and CEO, for any closing remarks.

[Chuck Rubin:]

Thank you, Rocco. You are a tough moderator, I appreciate this. In closing, let me just remind everyone of some of the points that we made. Our industry is facing some near-term headwinds, but we are taking steps to address what we can control and improve our performance. I want to thank all of our 50,000 team-members for their continued commitment and hard work in pursuit of our long-term objectives. I would remind everybody that we have an incredibly strong financial model. We believe we have a compelling long term strategy for growth. And we intend to leverage our leadership position and our financial strength to aggressively pursue additional market share gains and drive operating profit dollars while continuing to return capital to shareholders through share re-purchases. Appreciate everybody taking time to join us today, and we look forward to discussing our fourth quarter in March with you. Thank you everyone.

[Operator:]

And thank you sir. Today's conference has now concluded, and we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.